What are Put Options?
Put options are the tool most likely to be used by grain producers. They are the right, but not the obligation to sell futures. However, there seems to be confusion by producers in understanding the distinction between puts and calls. Here is how to keep them straight. Aunt Martha gave your wife her prized vase, the only one of its kind. Your three-year-old son, or daughter, likes the vase and runs through the house waving it! Your wife is frantic. What does she tell your son or daughter? Put It Down! Remember, a put is used to protect the producer against lower grain prices.
Puts are like futures in that they can be bought or sold. The purchaser of a put pays a premium that is paid to a seller. The buyer of the put thinks the grain market is going lower. The seller, however, receives the premium, as he believes prices are headed higher. Most likely, the seller of the put is a speculator. If the buyer pays 30 cents for the put, this is the most that he can lose. If prices go lower, the put increases in value. There is no margin requirement to buy puts as they are a right, not an obligation to sell futures. The seller, on the other hand, received the 30-cent premium with the intention that prices are going lower. The premium received is his maximum profit and he has unlimited risk if the market goes higher. Since there is unlimited risk, the position must be margined. If prices rise by 10 cents, theoretically, they could receive a margin call of $5,000.